Plummeting oil prices and quantitative easing have global significance

While the US ceased quantitative easing (QE) in October 2014, Europe commenced QE and in Japan it continues. China is seeking to stabilise growth, as seen in the recent cut in interest rates, while on 3 February 2015, Australian cash rates were lowered from 2.5 per cent to a record low of 2.25 per cent.

Global share markets have been generally supported by declining interest rates and while this support is likely to continue, markets have clearly already derived the benefit of ultra-low rates.

Oil

Weak oil prices could have geopolitical consequences. For consumers in oil importing nations such as the US, China and India, current prices are cash flow positive as less is paid at the fuel pump. However, for oil exporters including Russia, the consequences are significantly negative. Lower prices, coupled with sanctions, are placing strain on the Russian banking sector to the extent that a debt default is possible if current prices are maintained in the longer term. Given its reliance on oil, Venezuela could default on its debt as early as March.

The Russian Ruble plunged in 2014 reflecting the challenging economic environment and, in 2015, there will continue to be major risks in the Russian financial system if current oil prices are sustained.

US

The US is enjoying sound economic growth, a share market trading at record levels and low long-term interest rates  (all at the same time). This doesn’t appear sustainable, even though the Federal Reserve has flagged higher rates, leaving the bond market susceptible and share markets possibly challenged.

US corporate earnings growth revisions have recently been scaled back, hence the expanding price earnings ratio. US shares are trading on a forward multiple of 16, which is above historical averages. At these levels, the market is factoring in strong earnings growth due largely to the strength of the US economy.  This year may well be a case of a strong US economy already being priced in.

Europe

European GDP growth has been anaemic, however the introduction of QE is expected to benefit in the medium term and low inflation remains a near term concern. As Germany is the economic export engine of Europe, they will likely experience some relief from the weaker Euro. While QE is a positive step, political risks in countries such as Greece are likely to remain elevated.

To date, European Central Bank (ECB)  actions have failed to lift growth as banks have been reluctant to lend. With negative interest rates in Europe, banks are increasingly likely to lend however this will take time.

China

While there is no doubt the economy is slowing, the Chinese share market staged a significant rally in the latter half of 2014 from the undervalued levels earlier in the year.

The China rally is one that has been influenced by recent Chinese policy initiatives. Official interest rates were unexpectedly cut during the quarter and the government has now allowed foreigners to purchase mainland China shares. Further, with house prices having weakened in China, there may be new funds directed toward non housing related growth assets in China and abroad. 

Although China is expected to be a beneficiary of lower oil prices, the end of the residential construction boom is being felt across the economy. As a result, and in anticipation of the slowing growth rate, China’s official borrowing rates were reduced in November 2014.

Australia

The outlook for Australia is more challenges given falling commodity prices. The price of iron ore (our largest export) averaged around $US90 in 2014 but towards the end of December was trading at around $US70 – the lowest since 2009. Price weakness is also impacting the federal budget. In fact, the government recently slashed its price forecast for iron ore in 2015 by a third – from $US94 in September to $US63 a tonne in January. Unemployment was at 6.1 per cent in December and the Reserve Bank of Australia (RBA) is concerned that the unemployment rate may rise more than previously expected. This is a contributing factor to the RBA reducing interest rates to a record low of 2.25 per cent. 

All these factors have been major contributors to the decline in the Australian dollar. While a weak dollar should make Australia more competitive, especially in relation to exports, this will not make up for lower commodity prices which means the dollar is likely to experience further weakness.

 Source: IOOF

Contact Wynyard Park Private Wealth to discuss your investment options for 2015.